Earlier we reported that federal regulators have proposed new rules requiring very large banks to meet a liquidity coverage ratio standard established by the Basel Committee on Banking Supervision. As the industry digests the proposal, it is becoming quite apparent that it likely will have significant consequences for non-bank firms.

Once the liquidity coverage ratio is established for a bank, it will be required to hold "high-quality liquid assets" to cover that ratio. That is, it will be required to hold high-quality liquid assets at least equal to a "total net cash outflow amount" reflecting an estimate of the amount of cash flowing out of the bank over a 30-day period.

The first problem for non-banks comes when it is realized that the definition of the term "high-quality liquid assets" does not include state or local government bonds. The regulators believe that such bonds are not liquid and readily-marketable in U. S. markets as such securities generally have low average trading volumes.

However, excluding such bonds from satisfaction of the liquidity coverage requirement may well disincent the largest banks from investing in such bonds which could have negative market implications for those bonds.

Another problem for non-banks with the proposal is that it requires large banks to calculate cash outflows against which they must hold high-quality liquid assets by including in the calculations, among other things, 30% - 100% (depending on the status of the firm receiving the facility) of the undrawn amounts of liquidity facilities issued by the banks. The outflow calculation would include 30% of liquidity facilities provided to firms that are not regulated financial companies, investment companies, non-regulated funds, pension funds, or investment advisers. The calculation would include 50% of the undrawn amount of all committed liquidity facilities to banks or their holding companies and 100% of the undrawn amount of all committed liquidity facilities to regulated financial companies, investment companies, non-regulated funds, pension funds, investment advisers or special purpose entities (other than SPEs consolidated with the bank) or other firms. Some fear that this will disincent the largest banks from issuing liquidity facilities or may force them to increase the pricing of such facilities because the issuance of such facilities will require special liquidity support at the bank by increasing its liquidity coverage ratio.

Increasingly, it appears that developments in complex bank regulation have significant indirect consequences for many others.